Introduction and description of a leveraged buyout
In a leveraged buyout, the shares of a target company are acquired by a specially created acquisition vehicle (the acquisition holding company), with the purchase price being financed largely with debt and, to a lesser extent, with equity.
Advantages of a leveraged buyout
The advantage of this financing method is that a relatively small investment of equity capital can generate a relatively high return on the share capital, provided that the (indirect) buyer of the shares of the target company (usually a private equity fund, via the purchasing holding company) succeeds in selling the shares at a profit after a certain period of time.
Bank financing for a leveraged buyout
The portion of the purchase price that is financed with borrowed capital is usually provided by the bank in the form of a loan to the purchasing holding company. The purchasing holding company is usually an empty shell with no assets other than the shares in the target company.
Collateral provided by the target company in a leveraged buyout
In a leveraged buyout, the bank requires collateral when granting the loan to the purchasing holding company. This is done by the purchasing holding company granting the bank a pledge on the shares it holds in the target company. The bank often requires that the target company and its subsidiaries also guarantee the interest and repayment obligations of the purchasing holding company. In that case, the target company provides security on its assets for the benefit of the bank.
Rules for directors and supervisory directors when providing security
The target company’s guarantee for the purchase holding company’s obligations towards the bank and the provision of security on its assets to the bank are subject to rules laid down by the Enterprise Chamber.
Firstly, advice must be sought from the target company’s works council. Furthermore, rules apply to the directors and (if applicable) supervisory directors of the target company.
It is important for the director(s) of the target company to bear in mind that a leveraged buyout involves a considerable (potential) financial burden for the target company. In the interests of the target company, the directors must therefore consider it their duty to weigh up all the advantages of the leveraged buyout against the (potential financial) disadvantages. This weighing of interests is not only a question of whether the continuity of the target company is sufficiently assured by the provision of the securities, but above all whether the continued success of the company will benefit from the leveraged buyout and whether the leveraged buyout will enable the target company to implement its strategy.
What is expected of directors and supervisory directors in a leveraged buyout
Directors are expected to ask themselves repeatedly from the start of the takeover process whether the decision in favor of a leveraged buyout and the specific terms and conditions thereof are in line with the interests of the target company. The directors must take a proactive stance in this regard and, where necessary, counterbalance the parties involved in the leveraged buyout, including the private equity fund and the bank.
This is where the dynamics of the takeover process come into play, as directors are often required to make last-minute decisions with far-reaching consequences, even though they were not involved in the preparations for these decisions, or only to a limited extent.
In practice, the private equity fund usually negotiates with the bank on the terms of the loan to finance (a large part of) the purchase price of the shares of the target company. It is not uncommon for the directors of the target company to only be informed of the financing conditions shortly before the intended acquisition date and to be expected to take a decision “overnight” on the provision of security by the target company and its subsidiaries.
All this while the Enterprise Chamber expects the directors to take careful decisions, whereby the directors have obtained sufficient insight into the possible consequences of providing security prior to the decision-making.
Specifically, the directors are expected to:
- Make a careful and transparent inventory of the obligations arising from the provision of security;
- Have the advantages and disadvantages for the target company associated with the security (and the fact that it could consequently become liable for the obligations of the purchasing holding company under the acquisition financing) assessed objectively and externally;
- Make a specific assessment of the risks of the security for the interests of the target company and its business, weighed against the benefits to be gained.
In doing so, the directors are also expected to stand firm and be able to counterbalance the often emphatic wishes of other parties involved in the leveraged buyout to complete the acquisition without delay.
The supervisory board (if applicable) is generally expected to carefully weigh all interests involved and to perform its supervisory and advisory role in a meaningful manner. This means, for example, that the supervisory board is familiar with relevant documents and that it adequately assesses the management decision to provide security against the interests of the target company. The supervisory board must also carefully weigh the advantages and disadvantages of providing security.
Risks for directors and supervisory board members in leveraged buyouts
The consequences for directors and supervisory board members if they fail to meet these expectations and the transaction subsequently fails are serious: they may be accused of mismanagement, for which they may be held liable.
Following on from this article, see also Deficiencies in participation – LVH advocaten Rotterdam.
Information
If you have any questions about this article or this subject, please contact Peter Verheijden.
